Global recession. US/China trade war. Brexit. Low interest rates… What to do?

Markets

It feels like there is more global uncertainty at the moment. Things such as a global or domestic economic recession, US/China trade war tensions, Brexit, Trump’s rhetoric, the prospect of zero (or negative) interest rates, what property prices might do here, all seem to dominate the news. You may find these matters confusing and they can create inertia.

So, how do you navigate these seemingly turbulent times?

Consider issues in a long-term context

Last week, the Australian share market fell 3.7% between Tuesday and Thursday. These types of dramatic movements attract alarmist headlines. The reality is that despite this drop, the market is still up 10.1% over the past 12 months, which is much better than other developed markets.

The volatility (VIX) index is the most common measure for the level of volatility in the US market and is charted below for the past 20 years. The VIX index averaged only 13.2 throughout calendar years 2016 and 2017, which is well below the long-term mean of 18.3. Since the beginning of 2018, the VIX has averaged 16.6, which is 25% higher than 2016 and 2017, but still below the long-term mean.

Markets

Perhaps this puts recent share market volatility in context. Whilst the market is more volatile than it has been in recent times, in context of longer-term data, it is actually not all  that volatile. For example, there was almost twice as much volatility between 2008 and 2011.

I share this with you to make the point that it is important to focus on the data and facts rather than how markets feel.

Most of these issues are short term

The best way to deal with these often-exaggerated topics (as listed in the headline) that the media, in particular, love to talk about is to ask yourself whether these are likely to have had an impact 20 years from now. Mostly, the answer is no. Many of these “issues” are short-term in nature and really won’t have any impact on long term investment returns.

Markets and economies move in cycles, so recessions aren’t a new phenomenon for long-term investors. Government trade terms and strategies change, but markets and business always adapt. Perhaps the only factor that might have an impact in the long run is interest rates, particularly if they are lower for longer. But that impact is likely to be positive for astute investors.

In short, what I am saying is; “play the long game”. Focus on long term outcomes. If you do that, you don’t need to worry about getting distracted by all the short-term noise and as such, it is less likely you will make a decision that you may regret in the future (or regret not making any decisions).

Short term thinking creates unnecessary and unhelpful anxiety. You end up focusing on whatever dominates the news – there is always something to worry about. To avoid this ask yourself, what can you do today that is likely to strengthen your financial position 20 years from now. Forget about what might happen over the next 20 days or 20 months.

Focus on quality, methodology and valuation

If you are investing in shares, you must focus on ensuring you adopt the correct methodology and skew your investments away from over-priced markets. If you are investing in property, focus all your energy on quality only. Doing this is the best way to ensure your investments are strong enough to weather any storms that might be coming our way. I explain these two factors below:

  • Quality and methodology – ensure you have a sound methodology for selecting your investments. If you are investing in equities, arguably it would be better to adopt a valued-based approach if you share my belief that the equity bull-market is approaching its end. If you are investing in property, focus on the basics of supply and demand e.g. strong land value component in an area that has scarcity and therefore benefits from sustainable, excessive demand. Historic performance is an excellent guide.
  • Valuation – the best way to protect future share investment returns is to skew your investments away from over-priced markets. Your starting valuation will tend to have a big impact on future investment returns. It stands to reason that if you invest in markets that are “cheap”, your downside risk is low whereas if you invest in markets that appear overpriced and the bubble bursts, you will probably lose money!

When investing in property, unlike with shares, the current valuation has little impact on future returns because the property market is less volatile, so intrinsic and market values tend not to differ substantially. Property has always seemed expensive unless you take a long-term view. Of course, that doesn’t mean you shouldn’t take steps to avoid over-paying for a property, so make sure you get professional advice!

The short-term hysteria sometimes creates opportunities

Another thing you can do is use some of this short-term noise to your advantage. For example, the US/China trade tensions have weighed on emerging market valuations. Emerging markets include countries such as China, Taiwan and India.

The price-earnings ratio (see this blog for what this means) for emerging markets (FTSE Emerging Markets All Cap) is currently 12.8 times. Compare that to the US market (S&P 500) which has a price-earnings ratio of over 21 times – 64% higher! This and other measures (such as book value/price) make ‘emerging markets’ look cheap, by comparison.

As Warren Buffett suggests, the share market is a popularity contest in the short run. However, in the long run, it is a weighing machine in that it’s the fundamentals of markets that will determine long term returns, not popularity. Emerging markets are not popular at the moment because of President Trump’s actions. Perhaps you can take advantage of this in your portfolio?

A word of warning: this is an example only. Emerging market are high risk investments. Typically, less than 5% of your portfolio should be invested in emerging markets. Also, indexing (passive strategies) don’t work as well as they do in developed markets, so it is best to use active management. Just be careful.

It’s times like these you must block your ears, close your eyes and play the long game.

I started this blog with a statement that “it feels like there is more uncertainty at the moment”. The most important word in that statement is; feels. Feelings are often shaped by two emotions; fear and greed. Neither of these emotions are particularly helpful when it comes to making financial decision.

Avoid allowing the news of the day to shape your financial decision including the temptation to delay making a decision i.e. procrastinate. Instead, put your feelings aside and look at the facts. Make an evidenced-based decision. Get astute and independent advice. And most of all, focus on the long run i.e. the best investment you can make today that will maximise your wealth in 20 years’ time. What happens over the next 2 years (for example) is completely irrelevant, so don’t waste any time thinking about it.